Trading Strategy I: Fundamental Long/Short Equity

Style: fundamental equity long/short complemented with sector/theme concentration approach, with aim to generate superior absolute returns on a consistent basis in a risk adjusted manner with relatively low correlation to the overall market.

Long: good business + attractive valuation + competent mgmt + value-unlocking catalyst in 6-9 months (ideally under-followed, under-researchedd, or contrarian)

Short: poor business + expensive valuation + bad mgmt (ideally sentiment not turning negative yet but starting to show skeptism w potential negative catalyst)

I. Screening process: Fish where fish is.  (strategic, sector or topical or stock-specific themes, but most importantly pleasing God)

– strategic investment

– secular growth trends (demography, policy direction, tech standard migration, etc.)

– cyclical inflection point (e.g. inventory level, marginal producers’ cost vs. pricing, etc.)

– policy/economic restructuring prospect

– bottom-up deep value

– Palm pilot/”flatten” names

– sell-side research reports

– intensity of sell-side following (looking for under-followed names)

– sophistication of sell-side research (looking for under-researched or complexity names)

– consensus calls on the sell-side (looking for contrarian ideas)

-significantly split views from the sell-side (looking for controversy/binary-outcome ideas)

=> a combination of growth & value investing approach can keep myself out of any kinds of insanity and hopefully can time the market to some extent.

 II. Research process: Indentify beautiful fish (good business model + good mgmt + good valuation + free “calls”)

– source of free calls: hidden assets, new products, regulatory changes,

– certainty + sustainability + visibility (3Ties) for each line of businesses

– look for mispricing opportunities out of mkt inefficiencies

         – extreme pessimism or optimism (overdone) in either individual stock or overall markets

         – disconnection btw. macro concern and micro fundamental

– stock-level, most often found in situations where controversy/complexity/contrarian (3Cs) opportunities exist

– look for re-rating catalysts

– research edge

         – on-the-ground “kick-the-tire” research (1+ companies per day)

                   – understanding business

                   – relating to product

         – due diligence via customer/competitor checks (GLG)

         – knowing people via networking (ex-banker relationship)

                   – background of mgmt

                   – inside track

 III. Portfolio construction process: Maximize profit from beautiful fish with identifiable catalyst and good judgment of timing (behavior analysis with 2nd or even 3rd derivative consideration)

– concentration (top 10 equity as 1/3) – top 5 longs + top 3 shorts => 80+% of total return

– spinoff/splitoff

– asset disposal

– regulation

– priced in? (expectation vs. reality) + controlled entry point

IV. Trading/Execution process: control of timing and entry point

–          For cyclical names: need 1) absolute value (based on asset value mark-to-market); 2) loss peaking (so marginal suppliers dropping out) or utilization rate turning up; 3) inventory hitting critical point plus 4) underlying demand not weakening anymore. Anything else, e.g. pricing reversal, positive pricing signal, etc. to be confirmation to add positions

–          For contrarian names: absolute value based on discount to private market transaction value is the key consideration for entry point; timing harder than cyclical names but could be managed if following companies closer to pick turning points

–          For controversial names: no way to time but either organic research convincing or getting discount to free “call” (hence margin of safety in case negative “call” value dragging down stock price)

–          For complex ideas: no way to time but establish or add position as long as there is more convincing research data points

–          For all ideas, if there is overdone reaction of stock price in response to news/rumors, as long as absolute value shows up, take advantage of liquidity generated

–          Whenever a name doubling, sell down if not out; whenever a name tripling, sell at least half (all against original purchase price)

–          Whenever a name down 20%, sell down if not out; whenever a name down 30%, sell at least 1/3; whenever a name down 50%, sell at least 50% (all against original purchase price)

V. Shorting (3Fs)

– fraud

– fad (or hyped)

– failure

Never short:

– cheap or reasonably valued stocks

– good companies doing well (i.e. Earnings still growing at reasonable pace vs. Mkt expectation)

– cash-rich companies (until that cash spent) with shrhlder-friendly mgmt

 shorts are not appropriate for trading, even less so cf. longs – as a result, timing and entry level are extremely important.

– strike a balance btw. Contrarian/non-consensus and being too early

– don’t short just ’cause everybody is long

– don’t short too early if stupidality is obvious but has gone to the extreme

VI. Check points before trading

 WHY (thesis/rationale)

WHY NOT (risk)

WHY NOW (timing, Valuation + identifiable catalyst)

=> essense: finding mkt inefficiency derived “mistakes”

– tendency to go extreme on both upturn and downturn

– inertia inherent in herd mentality (slow to change)

=> behavior derived ineffiencies creat superior risk/reward opportunities on both macro and micro level

Neglect/ignorance (under-follow)

Complexity (under-research)

Contrarian (revert-to-mean for over-reaction) Controversy (mis-understanding)

=> structual inefficiency

Bottom line:

Is the mkt wrong (identification of inefficiency)?

Why (factual observation of inefficiency)?

How come (source of inefficiency)?

Selling discipline/Key to managing reinvesting risk

 GARP: can hold on

Value: can have guts to buy when truly depressed

Momentum: can tell when to get out


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